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By Shahid Kardar THE PPP government had, admittedly, inherited a difficult situation. Unfortunately, however, it took a casual view of the challenges that lie ahead. The finance minister’s budget speech did not articulate a vision or medium-term strategy to address these, partly because the government has been thrown into the deep end, given the political uncertainty and the timing of election.
That we find ourselves in this situation is not just because of the unparalleled increases in international prices of commodities like oil and food grains but because government expenditures had run wild. It is important to understand our predicament because of this factor, since the foremost issue is not the level and volume of taxation but what tax payers are being provided from their tax contributions. To illustrate the point take the following examples of what has been happening to expenditures with tax revenues increasing from Rs386bn in 1999-2000 to a trillion rupees in 2007-08.
Defence expenditures have risen from Rs150bn to Rs320bn (including military pensions), this works out to US$34 per capita against US$23 for education and health combined. New F-16s are being purchased and Rs75bn were overspent during the year just ending.
And there is no debate on whether we are getting value for our money.
Similarly, take the case of civil administration. The expenditure has grown from Rs48bn to over Rs140bn. Six aircrafts were bought in recent years for the president, the prime minister and the four chief ministers, with countless bullet-proof and luxury high fuel consuming cars, innumerable lavish foreign trips of VIPs (and nothing has changed with the prime minister, who two weeks ago took an entourage of 84 for Umrah).
Again, the Public Sector Development Programme (PSDP) of Rs550bn supports additional homes for federal ministers although the concurrent list is being abolished. Add to this list the schemes that should be implemented by the provincial or local governments, low priority projects not being dropped, etc. and you get a flavour of the quality of the much celebrated PSDP.
The assumptions on the budget deficit (4.7 per cent of GDP) and inflation (12 per cent) are optimistic. Although the announcement to freeze non-salary expenditure components, the ban on purchase of new cars and the reduction in the budget for the PM’s secretariat (the latter having symbolic importance) deserve praise, we do not see a serious effort to cut expenditures.
And these are our bane — particularly the spending on defence, administration and the general untargeted subsidies on oil, fertilisers and electricity consumption of the more affluent. The target of the budget deficit is ambitious for the following reasons:
a) The current expenditures appear to be significantly underestimated, the best example being provided by the decision to allow interest charges to go up nominally despite the increase by almost 20 per cent in debt, to raise interest rate by two percentage points on the National Savings Schemes and shift borrowing to sources other than the State Bank.
b) The full cost of the 20 per cent salary increase and the enhancement of pensions of retired civil and military personnel have not been fully factored in, with this bill being particularly steep for the provinces.
c) While increased reliance on indirect taxes has been preferred, it is estimated that collections from direct taxes could go up by another Rs100bn with little additional tax effort. But this may not actually happen.
d) The target of 25 per cent growth in tax revenues looks unreasonable even if we factor in the tax mobilisation proposals of Rs66bn.
This is so because industrial production and competitiveness (and thereby economic growth and government tax revenues) are expected to be hit by energy shortages, the increase in interest rates as monetary policy is tightened further, the L/C 35 per cent cash margin requirement and the phasing out of oil and electricity subsidies. In other words, the budget deficit may well be two percentage points of GDP higher.
Sadly, no attempt has been made to begin to tackle the structural and systemic issues that saddle the tax regime. The government has chosen to tax the already taxed sectors (by simply increasing GST to 16 per cent and by enhancing excise duty on cement, telecommunications, financial services) rather than improving the structure, removing the distortions in the incentive systems and expanding the coverage/base to other exempted (agriculture) or lightly taxed sectors like services and trading in listed shares.
This will simply incentivise evasion. Nor has the issue of definitions been resolved, with trading incomes of stock market and real estate brokers continuing to be treated as capital gains and exempted from taxation, without the Capital Value Tax (CVT) on transactions being raised.
Yet another — fourth one — amnesty whitener scheme at two per cent has been announced despite the tried, tested and failed experience of such initiatives.
Duty on all imports has been increased by one per cent and on 300 ‘luxury items’ by 30-35 per cent — ostensibly to narrow the trade deficit by discouraging imports. Although the measure is well-intentioned given our weak administrative mechanisms and systems this is more likely to succeed in encouraging under-invoicing and smuggling.
Also, while passing on the increase in international prices of oil over a shorter period there is a need to consider reducing the GST to five per cent (or to a specific subsidy) to ensure no revenue loss for two years to raise it back to 15 per cent when the economic situation improves.
Moving to the direct poverty addressing measures, the scope of the cash transfer programme (the Benazir card) is disappointing considering that there are around 10 million households below or hovering around the poverty line that need help urgently for the next year or so. Moreover, the use of this card as an instrument of payment will not be transparent. To prevent leakages we need public display of the names of the beneficiaries and public distribution of the grant.
The other worrying aspect for which there are no easy answers, except that perhaps the untargeted subsidies should only be withdrawn (with all the implications for the budget deficit) when the system of cash transfers is fully in place.
Whereas the demand is for immediate relief setting up the system could take as much as six months, and is likely to continue to exclude a sizable chunk of eligible beneficiaries (in Fata, Balochistan, interior Sindh) with no ID cards.
The government has chosen not to spell out its strategy to finance the massive current account deficit projected at US$13bn for next year, especially if the domestic and international environment for privatisation and floatation of Global Depository Receipts (GDR) remains murky. Although there has been a net capital inflow, the bulk of them are sources either volatile or tenuous in nature, raising serious questions about the stability of the external sector.
However, the biggest challenge for the government will be the management of public expectations. This holds especially true with respect to subsidies (particularly of wheat flour from the three million tons of high cost imported wheat and the R&D subsidy for industry). The planned reduction in subsidies will require significant increases in electricity tariffs, oil and wheat flour prices, a politically daunting task.
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